As Austerity Shrinks Government Budgets, Contractor CEO Pay and Public Costs Set to Rise

6/4/2013

In the midst of shrinking federal spending on infrastructure, scientific research, Head Start, and other government programs, the costs of government contractor executives’ salaries and compensation are set to soar unless Congress takes action. This is another example of how current government policies transfer resources to the wealthy and away from the programs that broadly support and grow a vibrant middle class.

The maximum amount a government contractor can charge taxpayers for employees’ salaries is about to rise at least 25 percent in the next few weeks, from $763,029 to more than $950,000 – nearly $1 million. This comes as federal employees have seen pay freezes – justified on the basis of saving public dollars – and as most Americans have seen stagnant incomes over the past several years. It also comes as federal spending is reduced through the Budget Control Act of 2011 and sequestration.

The limit is known as the contractor compensation cap. The annual increases in the cap have grown wildly out of control, far outstripping the pace of inflation as most Americans’ household incomes have stagnated, according to the White House and some in Congress. In recent years, both the executive branch and Capitol Hill have floated proposals to revise this cap and the formula for calculating increases.

The proposals vary in how widely the caps would apply to contracts and how much lower they would set the cap. In its latest legislative proposal, the White House’s Office of Federal Procurement Policy (OFPP) has significantly backed down from the aggressiveness of its earlier recommendations. The details are contained in a legislative package that the Department of Defense sent to Capitol Hill on May 15.

The American Federation of Government Employees (AFGE) was strident in its criticism of the White House’s new position. AFGE’s President J. David Cox Sr. told The Washington Post that “Federal employees have had their pay frozen for three straight years, and more than 800,000 employees are being furloughed without pay for up to 11 days this year under sequestration… And the best the administration can do [is] impose this small change that will affect less than half of all service contracts.” The Project On Government Oversight (POGO) stated in a blog post that “the White House shift in policy especially inside OFPP, is startling and might be bad news for taxpayers.”

Congress Should Take Action

Currently, the formula for deriving the cap is pegged to private sector executive compensation. This cap does not determine what contractors actually pay their executives and employees; it only caps the amounts taxpayers are charged. However, “as a result of skyrocketing executive pay, the tab for taxpayers has soared to unreasonable heights in the intervening years,” OFPP’s acting administrator wrote in a blog post last year. “Unfortunately, Congress failed to reform the current reimbursement formula for contractor executives and, until it does, taxpayers will continue to foot a bill that is both unjustified and unnecessary.”

The spectacular rate of increase in the amount of corporate executive pay has serious implications for taxpayers. “As a result of this rapid growth of private sector executive compensation over the past 15 years, taxpayers are being forced to reimburse contractors at a rate which has outpaced the growth of inflation and the wages of most of America’s working families – as well as the growth of Federal salaries,” according to the White House.

Cap Amounts: How Low Should They Go?

The savings could be substantial if the cap were lowered – but the extent of the savings would depend heavily on the details of which proposal is adopted.

For instance, in response to a question from Sen. Claire McCaskill (D‐MO), the Army stated that it alone could save $6 billion annually on contract costs if a cap of $400,000 – the same as the president’s salary – were enacted. There are some questions about the way this number was developed, but whatever the exact number is, the savings would be much greater if the cap was applied to all defense and civilian agency contracts. It would also be greater if the cap was $230,700 – the vice president’s salary – as the White House originally proposed in its FY 2014 budget request. Last year, the White House proposed an even lower, $200,000 cap.

However, the White House retreated to the $400,000 figure in a blog post dated May 30. The White House stated that “hundreds of millions of dollars” would be saved if its proposal is adopted.

A lower cap – everything else being equal – would yield greater taxpayer savings. However, the lower end of the proposals – such as the $200,000 amount – would be significantly lower than the cap was when it began in the late 1990s, especially when adjusted for inflation.

The Cap Should Be Universally Applied

While the president’s plan would be a step in the right direction, it could create far more savings if it went further. Aside from the level of the cap itself, the president’s proposal explicitly limits the cap to cost reimbursement contracts that cover only one-third of contract spending overall.

Perhaps most noteworthy is what the proposal doesn’t affect: Fixed-price contracts that account for over 60 percent of contract spending. In Fiscal Year 2012, according to USAspending.gov, fixed price contracts represented over $300 billion in federal spending.

Unless the cap is universally applied, a majority of the potential savings from contractor compensation caps would be lost, as the Center for Effective Government pointed out recently in a letter to Joe Jordan, the administrator of OFPP, which is housed within the White House’s Office of Management and Budget (OMB).

A legal basis for applying these caps already exists in the current rules for buying goods and services with fixed‐price contracts. Whenever certain types of analysis are used with such contracts, federal cost principles apply to their pricing. Since the compensation caps are part of these cost principles, they would apply in these instances.

It’s simple: whenever Federal Acquisition Regulation cost principles apply to the pricing of a contract, the caps should apply.

Many types of goods and services procured under commercial item contracts should be purchased with either cost reimbursement or fixed-price contracts. Thanks to contractor‐friendly acquisition “reform” laws passed in the 1990s, the definition of commercial item defies logic. Weapons systems such as the Lockheed C‐130J, which is not sold on the commercial market and is specifically tailored for the U.S. military, were deemed commercial items. More common examples of “commercial items” are major subsystems such as avionics that are not commercially available whatsoever. Goods and services that are not commercially available should be purchased using the types of contracts that give the government the power to protect taxpayers; contractor compensation caps would also apply either to pricing or reimbursement under these agreements.

Currently, the cap applies to all contractor employees only at the Department of Defense, the National Aeronautics and Space Administration (NASA), and the Coast Guard. Elsewhere in the government, the cap applies to just the top five executives at contractor companies. The president’s proposal would expand the cap to cover all contractor employees, with exemptions in unique cases for highly specialized scientists and engineers.

Beyond Caps: More Aggressive Negotiation Needed

The cap should not be a blank check for contractors to charge the government whatever they please for salaries and other forms of compensation. The government can negotiate lower levels of compensation for contractors if the prevailing compensation rate is lower or if contractors are proposing to charge taxpayers unreasonable amounts.

This is a very real issue. A few months ago, the Department of Energy Inspector General (IG) released a report that highlighted the risk to taxpayers if there is a myopic focus on whether the cap is exceeded or not. The IG found that because the Department of Energy only focused on keeping compensation below the cap, taxpayers may have ended up paying $3.45 million more for the salaries of other contractor executives over a five-year contract.

A consensus seems to be forming within the government that the current situation is untenable. Legislation is being prepared – with bipartisan support and in both the Senate and the House – that would bring executive compensation back to a more reasonable level, but contractors and their allies are seeking to water down any attempt to get better value for taxpayers. The White House’s retreat from its earlier, more aggressive stance only weakens the negotiating position of the government, and Congress must step up to ensure that the cap is reined in.